5/10/2011 @ 5:00PM

Oil Company Earnings: Reality Over Rhetoric

America’s largest oil and gas companies recently announced their earnings reports for the first quarter of 2011. The figures were eye-popping:
Exxon Mobil
alone posted $10.7 billion in profits.
Chevron
and
ConocoPhillips
–the next two biggest U.S. firms in the industry–posted smaller but still impressive numbers of $6.2 billion and $3 billion, respectively.

All these results reflected large increases from last year’s numbers.

The expected political backlash came quick and hard. President Obama publicly pressed for new taxes. In reference to the Royal Wedding, the Democratic Congressional Campaign Committee sarcastically invited Americans to the “R-Oil wedding.”

Of course amid all the political posturing, none of these legislators stopped to ask why oil industry earnings had jumped–or what these new figures actually mean for Americans who not only buy gasoline but also are broad-based investors. Nor did the sound-bite artists consider the industry’s inherent price cycle and why economists link profits to economic coordination and growth.

Truth is, recent earnings aren’t the result of international conspiracy or corporate malfeasance or unbridled avarice–they spring from the basic fact that crude oil costs, and thus gasoline prices, have risen dramatically in recent months.

Political unrest in Egypt, Libya and other oil-rich countries has led to fears about the supply of crude oil, the essential component of car-ready gas, and driven up its market value. In fact, the price of crude oil jumped 16% in the first quarter, and today hovers at or above $100 per barrel.

Add to this increased demand for oil from China, India and other developing economies–and the weak U.S. dollar–and it’s no wonder that oil prices are high.

Higher crude prices translate into higher prices at the pump. The cost of a gallon of gasoline for the average American driver is now $3.98–up more than one-third from a year ago. Between January and March alone, the price of a gallon shot up more than 53 cents.

You’ll notice oil companies themselves inherit more than drive the process. If oil prices go up, so do gas prices and their revenues. Alternatively, if the price of gas drops, their revenues plummet–and there’s little they can do about it.

Industry profit margins are cyclical too. But on average, between 2006 and 2010, the largest oil companies averaged a profit margin of around 6.5%. This pales in comparison to profit margins in just about every other industry. The pharmaceutical industry, for example, routinely averages a profit margin of about 16%. The soft drink market is even more lucrative.

At the gas tank integrated oil companies make about 7 cents per gallon. Meanwhile, the government extracts more than 48 cents, on average, per gallon. That’s right: Uncle Sam takes nearly seven times more out of drivers’ wallets via taxation than “Big Oil.”

For working Americans higher gas prices do indeed mean higher costs of daily living. But strong oil industry earnings (and profits beat losses in just about anyone’s book) also lead to very real economic benefits for these exact same families.

Compared with a small fraction of oil stocks (about 1.5%) owned by corporate management, the vast majority of such investments are held by average Americans, primarily via retirement accounts. Independent research shows that 14% of industry shares are in IRAs and a full 30% held in mutual funds.

Another 27% of oil stocks are in public pension funds. And in these accounts, oil shares more than pull their weight. While oil stocks made up less than 4% of major pensions in four key states between 2005 and 2008, they accounted for 8.6% of returns.

As the revenues of oil companies improve, so do their stock prices. In turn, teachers, firefighters, policemen and millions of other public servants see their retirement accounts expand. And as most states are struggling to keep their pension programs solvent, oil stocks can help ease that pressure and stave off fiscal woes.

And the economic ripple effects don’t stop there. Oil and natural gas companies support more than 9.2 million U.S. jobs and have invested nearly $2 trillion in domestic capital projects over the last decade. Higher earnings mean more cash to plow into new projects and jobs.

Unfortunately the bloated political rhetoric generated by Capitol Hill raises the prospect of bad public policy. Some legislators have threatened to institute a brand new “windfall profit” tax in times of unusually high returns.

Such a move would saddle firms with new costs, which will get recouped with higher prices at the pump. Vulnerable American families would be squeezed. And firms would have less money to invest in new projects, leading to slower job growth and fewer employment opportunities.

Denunciations of America’s oil and natural gas industry ignore the fact that shifts in global supply and demand are behind increased prices of recent months. Resisting punitive politics will ensure that petroleum prices drop as political tensions ease and the dollar strengthens. Such market-based policy will also promote jobs, investment and income for America at a time when they are most needed.

Robert L. Bradley Jr. is the CEO and founder of the Institute for Energy Research.